Ex-ECB Member Orphanides: Bond-Buying Plan No Silver Bullet

The European Central Bank‘s plan to buy potentially unlimited amounts of government bonds of selected member states is legal but isn’t a silver bullet to end the region’s debt crisis, said Athanasios Orphanides, a former member of the ECB rate-setting Governing Council.

Addressing a research conference at theSwiss National Bank last Friday, Mr. Orphanides endorsed ECB President Mario Draghi‘s argument that Outright Monetary Transactions, as the latest bond-buying plan is known, don’t violate the bank’s core mandate, but mustn’t become a permanent form of support for ailing euro member states.

Instead, the euro zone’s permanent bailout facility, or European Stability Mechanism, should eventually undertake all purchases of state debt. Such a move would give the ECB the freedom to return to its “traditional role of providing the liquidity that may be necessary to implement ESM decisions, within its mandate,” Mr. Orphanides said. The SNB is due to publish the speech later this week.

Mr. Orphanides’ warnings about the plan’s limitations reinforce the perception that concerns about the implicit moral hazard aren’t restricted to hawks, such as Germany’s Jens Weidmann, the only member of the governing council to vote against the OMT plan at this month’s council meeting.

“It is essential to recognize…that the OMT cannot on its own provide the basis for lasting stability,” said Mr. Orphanides, who left the ECB at the end of April when his term as head of the central bank of Cyprus expired. He now teaches at the Massachusetts Institute of Technology‘s Sloan School of Management.

Mr. Orphanides acknowledged that the ECB’s plan would “provide temporary monetary financing support” to certain euro member states and warned that this support “cannot persist indefinitely.”

“[They] could be seen as supporting the reduction of financing costs of some member states at the possible expense of an increase of financing costs of other member states,” he added.

But the ECB’s actions shouldn’t be confused with monetary financing in the classical sense, he said, namely the financing of euro-zone public expenditure through inflation.

“This is not the case. When looked at from the perspective of the euro area as a whole, the ECB is taking care to stay true to its mandate of pursuing and defending price stability in the euro area as a whole,” he said.

Mr. Orphanides, who was educated at MIT and was a member of the U.S. Federal Reserve‘s policy staff from 1990 to 2007, warned that “the ECB is ill-suited” to redistribute public finances among member states, saying that this is more the remit of elected politicians.

“It is the governments themselves that should control the extent to which fiscal resources are transferred to a state under pressure and the extent to which mutual insurance on the cost of financing is engineered,” he said. “The ECB, as the central bank of the euro area, could facilitate the implementation of these political decisions, within its mandate.”

Mr. Orphanides expressed concern at the lack of political progress in setting up the necessary institutions for a region-wide banking union. European finance ministers ended two days of meetings in Nicosia Saturday still far apart on how to create the safety nets that are needed as a complement to new rules allowing the ESM to recapitalize banks directly.

“The absence of a solid proposal to create a European agency for deposit insurance is not encouraging,” he said.

Europe needs an institution similar to the Federal Deposit Insurance Corp. in the U.S., which guarantees bank deposits in all states, he said.

“An FDIC-type authority with taxing power on deposits in the euro area as a whole would be able to finance bank resolution, and do so efficiently, working together with the ECB in its new supervisory authority,” he said.

Mr. Orphanides warned that “without a stronger political union that limits significantly the sovereignty of state governments to control their future spending decisions, solutions of the crisis that involve mutualization of risks associated with the issuance of sovereign debt would be detrimental to the European project over the long run.”

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